Stock Market Result Update on Tech Mahindra for 2QFY2012

Stock Market Result Update on Tech Mahindra for 2QFY2012 with a Buy recommendation and a Target Price of `707 (12 months).

For 2QFY2012, Tech Mahindra reported a mixed performance. The company’s revenue was almost in-line with our estimates, but its operating margin and core PAT came in below expectations. Growth came from non-BT business yet again, which grew by 7.3% qoq; while revenue from BT declined by 5.5% qoq due to closure of few projects. BT has now started retendering its work; this poses risk to Tech Mahindra’s revenue run rate. However, due to the company’s stake in Mahindra Satyam, we maintain our Buy rating on the stock.

Result highlights: For 2QFY2012, Tech Mahindra reported revenue growth of merely 2.2% qoq to US$296.2 due to flat qoq volume growth. In INR terms, revenue came in at `1,333cr, up 2.4% qoq. OPM slipped to 15.3%, down 337bp qoq, due to negative impacts of wage hikes given during the quarter and volume decline from BT. PAT, excluding share from Satyam, came in at `139cr, negatively impacted by higher interest cost of `72.1cr because it includes MTM loss of `52cr derived from foreign currency loans and higher depreciation costs.

Outlook and valuation: We expect the non-BT business to grow at a CQGR of 3.1% and 2.8% in 2HFY2012E and FY2013E, respectively, with BT’s quarterly revenue expected to be flat from here. However, there is a caveat that BT’s revenue may see a downside if the company loses out its market share in the retendering process initiated by BT. In fact, even if the company manages to hold the share or increase it, it can be margin dilutive as the client has initiated this retendering process as part of its cost-cutting drive with lower pricing expectation. Thus, we expect a 10.1% CAGR in USD revenue over FY2011-13E. The company’s core EPS is expected to have a negative CAGR over FY2011-13E. The only potential upside is due to the company’s stake in Mahindra Satyam, which is improving its overall profitability. We continue to value the company at 55% discount to Infosys’ target PE i.e., at 9x the company’s consolidated EPS of `78.5 and maintain our Buy rating on the stock with a target price of `707.